Consider passive funds when you’re trying to achieve precise exposure to certain asset classes (e.g. style-box investing) in a cost effective and tax efficient manner. Some narrow index benchmarks – think large-cap value stocks or medium-cap growth stocks — are generally easy to replicate with a passive fund. ETPs and other index products typically offer a low cost, transparent and tax efficient mechanism to gain exposure to such core asset classes, such as major equity or fixed income markets.
Think of passive funds for tactical exposure. For investors looking to tactically (i.e. frequently) adjust their exposures to certain markets and asset classes, exchange traded products (ETPs) are an excellent vehicle. They are liquid and cost effective, thus providing an ideal vehicle to adjust portfolio exposures based on short-term market conditions.
Many will notice one dimension that is missing from the above list: macro conditions.
Investors often ask if there are certain economic or market conditions that favor one style over the other. BlackRock’s research suggests that adopting a long-term, strategic framework governing the blending of active/passive is more productive than trying to flip from style to style. Each investment strategy offers its own advantages, suggesting that the most robust portfolio is a combination of both.
Of course, the right blend of index and active investments for you will depend on your particular risk tolerance and investing goals, but the five criteria above are a good starting point.
For more information on the differences between index and active funds visit iShares.com.
Sources: Bloomberg, BlackRock Research
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.